FedEx doesn’t look like Bill Ackman’s next target

FedEx Corp. meets most of the criteria outlined in Pershing Square LP’s letter to potential investors regarding its next activist target.

It is a large-cap, investment-grade U.S. corporation that principally operates in one business and trades at a lower multiple than its competitor. The company is also simple, predictable and generates free cash flow.

However, FedEx falls short on Pershing’s more important criteria, high customer switching costs and significant pricing power, according to RBC Capital Markets analyst John Barnes.

He also thinks the point regarding one principal line of business is debatable.

“While it’s true that the lion’s share of FedEx’s revenue and earnings are derived from package delivery, the company does so through several distinct networks, which we believe would be very difficult to integrate from both an operational and cost standpoint,” Mr. Barnes told clients.

The analyst also pointed out a US$3-billion investment would give Pershing Square a 9% stake in FexEx. That compares to a 6.2% stake for chairman and chief executive Fred Smith.

As a result, the hedge fund would likely have to fight a proxy battle to get management to take a new course of action.

“We believe such a proxy battle would be risky at this point since FedEx is still in the early stages of an aggressive series of turnaround initiatives,” Mr. Barnes said.

“After looking at this situation from every angle we can conceive, we are reiterating our underperform rating on the stock,” the analyst said, adding that “in the event that FedEx is not the target, we believe the stock will likely sell off aggressively.”

FedEx shares rose 4.4% on Tuesday after reports emerged that Pershing Square is in the process of raising a US$1-billion fund and will invest another US$2-billion of its own capital to take an activist position in an undisclosed target.

While the June 8 letter from Pershing Square head Bill Ackman identifies a 10-day time frame for raising the funds, this would likely be followed by a period of time to invest the money before the target company is identified.

J.P. Morgan analyst Thomas Wadewitz believes the potential for margin improvement in FedEx’s underperforming Express division could attract an activist investor. However, he thinks driving a management change would probably be much more difficult than it was for Pershing Square with Canadian Pacific Railway Ltd.

Following FedEx’s founder and chief executive, the next 10 largest shareholders own 43.3% of the company. Mr. Wadewitz noted several of these positions have been held for many years, so these shareholders may be inclined to support the existing management team.

“Given a nearly equal mix of positives and negatives it is difficult to form a strong view on the likely outcome, but on balance we are somewhat more skeptical that FedEx is the name in focus for Pershing Square,” the analyst said in a research note. “Our sense is that the commentary from the letter (free cash generative, customer switching costs, high barriers) does not imply a narrow characterization and that FedEx could fit a loose definition of the description.”

Mr. Wadewitz also thinks an activist could argue for faster and greater cost savings than FedEx’s current plan calls for. If that’s not compelling enough, the investor could push for a more aggressive and risky approach of combining the company’s Express and Ground networks.

“Considering the analogy of what Pershing Square did at CP, it would be necessary to identify a compelling leader to support as part of a proxy fight,” the analyst added. “While there are possibilities, we do not see an obvious candidate in small package who has the reputation and compelling track record in small package that Hunter Harrison at CP does with rails.”

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